Wednesday, January 27, 2016

We tend to assume our system for understanding the cause of failure must be sound, because we've experienced Roaring Success for so long.

Rip-Roaring Success is a funny thing: we assume it's the goal of every person, household, enterprise and nation, but we overlook that rip-roaring success can be as destabilizing as failure.

Rip-Roaring Success can destabilize in a number of ways.

One is the result of human nature. Those who didn't make it onto the Roaring Success Bus feel the gap widening most keenly. Indeed, psychological studies find we assess our wealth and social position not by the actual material prosperity we have, but by the narrowing or widening of the perceived wealth gap with our peers.

This is precisely the situation in the U.S. and China. Both economies are supposedly expanding smartly, but the gains are concentrated in relatively few hands; the Roaring Success Bus has few seats.

The vast majority perceive themselves as being left behind. That is highly destabilizing.

The second is a function of systems and human nature.

Every extreme eventually tends to revert to the mean, which is another way of saying that extraordinary growth rates of profits, stock market advances, etc. that characterize Rip-Roaring Success eventually return to merely average rates of growth.

This inevitably disappoints all who thought outlier rates of growth were permanent features of the system: Apple iPhone sales, China's GDP, etc.

This disappointment greatly exceeds the actual decline in the rate of growth, and the oversized reaction tips the system out of stability.

The collapse in the price of oil can be seen as an example: once oil was no longer behaving as expected, i.e. holding to $100/barrel, the reaction was swift and outsized.

The third is a function of organizations and systems.

Organizations that are hugely successful quickly lose interest in controlling costs. The money is pouring in so fast, every idea is presumed to be worthy of development, every functionary is presumed to need an assistant, and lavish parties celebrating the organization's roaring success become the norm, along with hefty bonuses and grand expansions of benefits.

Another way of saying this is costs that should have remained contingent and temporary become fixed costs. Once costs become fixed, the institutional resistance to eliminating them becomes fierce, and the organization slides into destabilizing crisis as rising fixed costs consume all profits/surpluses and start eating away at what little remains of truly productive activities.

The fourth is a function of success itself.

Success results from the optimization of productive capacity. In many cases, this optimization is accidental, or the result of chance alignments. Even when the optimization is entirely planned, a great many assumptions are made in designing that optimization: for example, that further investments of capital will continue to yield high rates of productivity growth, or that sales can continue expanding as product cycles become shorter, and so on.

But once conditions change, as they inevitably do in a dynamic world, the system that was designed to optimize for success is suddenly optimized for failure--yet nobody perceives the stagnation as the result of the very optimization that created the roaring success.

In effect, the organization is programmed to do more of what's failing.

In a previous post, I mentioned the example of World War II bombers that returned from missions heavily damaged. The experts examined the damage for clues as to what could be done to increase the survival rate of the aircraft.

This is entirely rational, right? The best way to improve results is to examine the sources of failure. But the experts did not examine the planes that were shot down--those planes whose damage caused them to crash. As a result, their observations were limited to those aircraft that were able to return to base. As a result, their conclusions were necessarily incomplete and misleading.

Put another way: we tend to assume our system for understanding the cause of failure must be sound, because we've experienced Roaring Success for so long. But the two skillsets are not necessarily related.

The fifth is a function of how we measure success. If a rising stock market is taken as the measure of success, then everyone watching stocks loft ever-higher assumes the system being measured (the economy) is experiencing rip-roaring success.

But the success reflected by the metric may be entirely artificial--for example, China's GDP. The choice of a single metric of success heavily incentivizes those in charge to game the metric to exaggerate the system's health and the competence of their leadership.

Ironically, a steady stream of small failures is the path to adaptation and stability. Experimentation results in a continual flow of failures that informs the process of maintaining progress. Organizations, individuals, households and economies that have been successful without experimentation are increasingly vulnerable to destabilization, for the reasons noted above.

In 2016, I suspect we will see previous success leading to destabilization as often as we see outright failure lead to destabilization.

This essay was drawn from Musings Report 45. The Musings Reports are emailed weekly to subscribers and major contributors.

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